What are Sector Funds? Meaning, Benefits and More

Published On: 12-Oct-2020

Many investors prefer investing in mutual funds, as it allows them to diversify their portfolio. While this may help the investors mitigate the investment risks to some extent, the returns may also get moderated. This is because a better performance given by one security may have been partially offset by another security, which has underperformed. Similarly, investors may want to invest in specific sectors or markets to benefit from available investment opportunities. Such investors may consider investing in sector funds, which provide a focused investment exposure for a particular sector. 

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What are Sectoral Funds?

A sectoral fund invests at least 80% of its net assets in equity stocks of the companies operating in a particular sector. These funds allow the investors to have a concentrated investment portfolio designed to capitalise on the investment opportunities available within that specific sector. 

For example, a banking fund will focus on banks and financial companies. Similarly, a consumption fund will focus on the companies operating in the FMCG and consumption sectors. As per the investment mandate, the fund managers must concentrate only on the stocks within a particular industry and do not have much flexibility to invest in other sectors. 

As of 30th Sept 2020, sectoral funds (coupled with thematic funds) have a 9% share amongst all open-ended equity schemes with an AUM (Assets Under Management) of Rs. 0.65 lakh crores Source: Association of Mutual Funds in India - AMFI.

Benefits of Sectoral Funds

Sectoral funds may be suitable when a specific sector is expected to rally in the market, thereby generating better returns for the investors. While one may also consider investing in a particular company to benefit from the uptrend in that sector, sectoral funds may be a good diversification option within the concentrated exposure of a specific sector. 

Who should invest in Sectoral Funds?

Sectoral funds may be a good investment option to benefit from the expected market uptrend due to market regulations, expected growth in the sector contribution, economic cycles, etc. However, the investors must choose to invest in sectoral funds only with a reasonably longer investment horizon, as the sectoral bets might be undergoing the gestation period and, thus, may take time to bounce back to better valuations.

These funds may not be suitable for new investors as the choice of the sector, and the investment timing is crucial to get valuable returns. Additionally, such funds should not be the only funds within the investment portfolio, and the overall portfolio should stay diversified across different market segments to mitigate the investment risk.

Taxation of Sectoral Funds

Sectoral funds may be classified as equity-oriented mutual funds under the tax laws, as the specified threshold for equity funds is 65% of investment in equities, while sectoral funds are required to maintain at least 80% equity investment in specified sectors. 

Investors are entitled to special tax rates as applicable for equity-oriented funds. The returns from equity-oriented funds, including sectoral funds, are taxed as capital gains when the investor redeems his/ her mutual fund investments. When the investment has been held for less than 12 months, the gains are termed as Short-term Capital Gains (STCG) and taxed at 15%. 

However, if the holding period of such investments is 12 months or more, the gains are termed Long-Term Capital Gains (LTCG) and taxed at 10% without any indexation benefit. Additionally, the investor is also allowed an aggregate exemption of Rs. 1 lakh for LTCG from equity shares and equity-oriented mutual funds in a year.

Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Finance Act 2020. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.

Disclaimer: The chart/information shared above is for illustrative purposes only and should not be construed as advise. The above is to illustrate the concept of asset allocation. There is also a possibility of the expected event not happening or some other unforeseen event that may affect the future performance of asset class. Investors are requested to note that there are various factors domestic and global that can have impact on performance of the asset class mentioned in the article. Information given is available in public domain.